ISSUE #5
Federal Estate Taxes

Although most Americans will not owe any estate taxes, it is wise to understand how the system works, just in case you may be affected. Even if your current estate is below the taxable threshold, make sure you monitor your situation. Inheritances, unexpected investment growth and tax law changes can push you into the taxable range. Here are some important points to keep in mind:

1. What is Estate Tax? -- The federal estate tax is levied on the value of your estate at the time of your death. Estate taxes in the United States were originally enacted to prevent the unchecked growth of immensely wealthy family dynasties. When Congress enacted the modern estate tax in 1916, the rates ranged from 1% to 10% for estates valued at $50,000 and up. This is about $11 million in today’s dollars.

2. Estate Tax History -- Although the estate tax was first applied only to the very wealthy, it gradually began to affect the American middle class because of inflation. As the dollar lost purchasing power, more and more families had taxable estates. Congress had also increased the estate tax rates. By the year 2000, the maximum rate was 55% and estate tax was levied on estates of $600,000 or more. This had become a real issue for many small business owners, farmers and people who saved for their heirs.

3. Tax Law -- To address this situation, Congress enacted legislation in 2001 to increase the exemption in steps from $600,000 to $3.5 million by 2009, providing substantial relief to the middle class. This legislation also eliminates the estate tax in 2010. Strangely, this tax law expires in 2011, causing estate tax rates and exemptions to revert back to the levels in 2001, unless Congress enacts additional legislation. This is a very confusing situation for taxpayers, so keep an eye on what Congress does.

4. Your Taxable Estate -- Everything you own at the time of your death is counted in your taxable estate. Your taxable estate may be much larger than you think. It includes such things as life insurance death benefits, balances in IRA and 401(k) plans, and real estate. You can get an estimate of your taxable estate on the internet with this calculator: http://personal.fidelity.com/planning/estate/index_calc.shtml

5. Estate Tax Exemptions -- Every taxpayer is entitled to an estate tax exemption. In 2004 and 2005, the estate tax exemption is $1.5 million. This means that you will not owe estate tax until your taxable estate exceeds that amount. If you think the value of your estate, including life insurance death benefits, may reach $1.5 million, you should meet with a qualified estate planning professional, so you can take steps to minimize your estate tax bill.

6. Estate Tax Rates -- The current estate tax is highly confiscatory, with rates ranging from 43% to 48% for taxable estates above the $1.5 million exemption. You can see why this tax has become such a big burden for family-owned small businesses and farms. These families have to pay a huge tax just to pass the business or farm along to the next generation. When the estate does not have sufficient cash, the family business may have to be sold to cover the tax bill.

7. Marital Deduction -- The unlimited marital deduction allows each spouse to leave everything to the other spouse tax-free. But if a couple’s estate exceeds the exemption, this plan can cause unnecessary tax. In these cases, it is important for both spouses to use their exemptions, which will provide a $3.0 million combined exemption for the couple. An estate planner can help you make these arrangements, which may save you several hundred thousand dollars in taxes.

8. Charitable Deduction -- Any amount you leave as a gift to a charitable organization is deducted from your taxable estate. There is no limit on the charitable deduction for estate tax purposes. You can plan to use charitable gifts to reduce your taxable estate, allowing you to pay less (or even no) estate taxes. When you do this, the cost of your charitable gift is less than 60 cents on the dollar because you are using funds that would otherwise be taxed.

9. Planning Issues -- Until Congress clarifies the estate tax situation, estate tax planning will be quite challenging. If there is any likelihood your estate may be taxable, you should have your situation periodically reviewed by an estate planner. This is the best way to make sure that you will be using all of the tax reduction tools that are available to you.